Ah, yes, credit scores. That three-digit number we’ve been told that summarizes our financial life!
Well, except it doesn’t summarize your financial life. But, it does indicate how trustworthy you are as a borrower, so it’s a good idea to get it as high as possible.
In Credit Part 1: Stop Overthinking Your Credit Score, I ranted about why you shouldn’t be overly obsessed with your credit score.
And you know what? I still feel that way.
A credit score is nothing to break your neck over, nor does it represent your actual wealth or ability to reach financial well-being.
But, there are opportunities to leverage credit so you still want to ensure you have a healthy credit history and associated score.
So, to keep the good times rollin’ in my month-long credit coverage, here’s Credit Part 2: 6 Things You Should Know About Credit Scores.
#1: It’s All About Your Credit Report, Not Score
While most people focus on checking and obsessing over their credit scores, what they REALLY need to be checking is their credit report.
So, what is your credit report exactly?
Your credit report is a record of your personally identifying information, history of debts, and credit/borrowing behaviors.
Account and balance information on open and closed credit card accounts, mortgages, auto loans/leases, student loans, personal loans, bills in collections, and bankruptcies will be on a credit report.
Each of three major credit bureaus – Equifax, TransUnion, and Experian – collect your personal and financial information and put it on a nice and snazzy report.
With this information, each (yes, each) bureau uses a scoring model to kick out your “credit score”.
So, the credit score is simply a result of what is on your credit report.
It’s the report, not the score, that will actually help you to pinpoint why your score is what it is.
#2: There’s Multiple Credit Scoring Models
Honestly, credit may be one of the most complex areas of personal finance.
Not because its particularly hard to grasp-it’s not. But because there’s so many levels to this ish!
For example, there is not just ONE credit score model. There are actually dozens of credit score models; all used for different purposes and by different lenders.
The most widely used is the FICO score. FICO, short for Fair Isaac Corporation, is by far the most well-known, and is used by 90% of top lenders.
We also have VantageScore, which was created jointly by the three major credit bureaus with the intent to compete with FICO.
VantageScores are not as widely used, but they’re gaining market share.
This is a good place for me to mention that many “free” apps and services that provide free credit scores actually are providing a version of a VantageScore. Credit Karma, Credit Sesame, Chase Journey and other similar services provide a VantageScore, not a FICO score.
Is that a bad thing? No, not necessarily. While it’s true that FICO is still the leading standard, the VantageScore can still provide you with a correlating idea of the health of your credit.
Plus, the scoring range is *now* in alignment with FICO (300-850), so it’s good enough for general trend tracking.
#3: FICO Is a Brand, and More Complex Than You Think
FICO is not the innocent little scoring model you may think it is. It’s actually a brand, and it’s quite the mystery.
Within the FICO brand, there’s more than 50, yes 50, different scoring models.
And guess what, you will likely NEVER know which model a particular lender is using at the time your credit is being reviewed.
Because of this, the score YOU think you have, likely isn’t the score a lender is looking at. Isn’t that fun?
VantageScore also has multiple models, and like FICO, is used by each of the “Big 3” bureaus.
So yes, TransUnion, Experian, and Equifax ALL issue a version of a FICO and VantageScore.
Also, different industries use different scoring models. For example, the FICO score model you pull through your favorite app will be different than the model a mortgage lender will use. Be aware!
Not confusing at all, right?
#4: How Your Credit Score Is Calculated
Ok, if you want to build a nice and strong credit score, you need to know this juicy info.
I’m about to give you the game! The best free game Google can buy.
By knowing how credit scores are calculated, you can evaluate your own credit behaviors for improvement.
FICO and VantageScore use slightly different models, but since FICO is used by most top lenders, let’s focus on how they weigh scoring variables.
Ok, this is what you need to know: the FICO model and scoring factors:
- Payment History (35%): Pay your bills on time! This is the most important factor in your credit score. If you aren’t paying on time, you are playing yourself, and your score BIG TIME.
- Amounts Owed (30%): Keep your utilization low! This refers to how much of your available credit you are using. In other words, if you have a $1000 credit card limit, don’t max it out! In fact, you want to keep your usage under 30%, so in this case, only charging up to $300.
- Length of Credit History (15%): The longer your credit history, the better. This shows that you are not “new” to this, which lenders view new borrowers as higher risk. As I mentioned in Part 1, credit is about trust!
- Mix of Credit (10%): Being able to show that you can handle of variety of debt looks good. So instead of having 10 credit cards and nothing else, having a car loan, mortgage and other types of credit in GOOD standing, plays to your credit score favor.
- New Credit (10%): You don’t want to open a bunch of new accounts within the same time frame. If you need credit, try to space out opening new accounts and keep hard inquires to two within a 2-year period.
This is the general model for how FICO scores are calculated. And I do mean “general model”, because truth be told, no one knows the EXACT scoring model or nuances. So, don’t go crazy trying to “figure it out”; you won’t be able to.
Just focus on learning the general basics of how to build and maintain a strong score, and then be like Elsa and let it gooooo….
#5: Credit Score Ranges
Once you get your credit score, where does that even fall in the eyes of a lender?
Each lender may actually have their own specific range, but the general FICO range is:
- Exceptional: 800-850
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Very Poor: 300-579
Remember how I said lenders may be using different scoring models and may have a different score than you show? Well, this doesn’t matter as much if you are firmly within a range (eg. 710, 780, 810+). But, if you are on a border (eg. between “Good” and “Very Good”), this can impact how a lender views your credit worthiness. You may think you have a 745, and a lender may score you as a 735, thus potentially offering you a lower tiered rate.
There’s not anything you can do about the fact lenders are likely using a different model than what is available to you, just be aware this difference exists.
#6: You Don’t Need To Check Your Score Every Day
It doesn’t hurt your score to check it as often as you want, but please, don’t go overboard.
Even if you have access to it through your bank, credit card company, or one of the many free services, it’s not necessary to check it too often.
Why not? Because day-to-day changes are less important than overall trends.
Since score variables such as available credit card balances, utilization, and age of credit are technically constantly changing, your score can also see constant changes.
The scoring and weighting of variables within the algorithm is constantly recalculating.
No need to freak out for small changes in the short term unless you see an overall negative trend.
It’s good to have a good understanding of what causes fluctuations, but don’t drive yourself crazy.
A healthier approach is to focus on a month to month, or maybe even quarterly trend.
It’s kind of like the stock market: if you focus on the daily movements, you’ll drive yourself wild.
The main goal is that the trend goes “up” in the bigger picture.
Oh, there’s so much to discuss with this topic.
Multiple scoring models, ever changing scoring variables, and striking the balance between score awareness and obsession.
Lot’s to learn and understand, but never forget that your credit score is only ONE piece to your financial puzzle.
Learn the credit game, build a strong score, and then refocus on what will help you reach complete financial well-being.